 Personal Finance PowerPoint Presentation What is a mortgage clause? Get ready to get financially fit by practicing personal finance. Most financial decisions can be broken out into short-term decisions, long-term decisions, the short-term decisions being the one that we're going to train our gut to trust our gut, ones that we're going to be tinkering with. We're going to have trial and error to help us hone down our habits so that we can depend more on the habits and not have as much cognitive thinking for the day-to-day decisions. For the long-term decisions on the other hand, we have to use the adage of measure twice, cut once. We don't have the trial and error that we can use for the short-term type of decision-making processes and therefore we need a more formal process in place. So these are some of the steps that we might go through or some categorization of them. Number one, determine home ownership need. Number two, find and evaluate a property to purchase. Number three, price the property. Number four, obtain financing. Number five, close the purchase transaction. So what is a mortgage clause? Most of this information can be found at Investopedia, which you can find online and continue your references and research from there. And this is by Matt Ryan Webber, published March 15, 2022. A mortgage clause is found in many property insurance policies and it provides protection for a mortgage lender if the property is damaged. So clearly when purchasing a home, most people need financing for the home because they're not going to be able to put down simply cash for the home and therefore they're going to need a loan. So the lender will typically have or need the collateral to be safeguarding the loan of the home itself so that if you don't pay back or you default on the loan, they have recourse against it. They can possibly foreclose on the home so that they could sell it and recap the loan amount in that event. That of course leaves the lender concerned with the value of the home as well because the value of the home is going to be important because it is safeguarding the event that you don't pay back the loan. Now notice that that does not mean though that the lender owns part of the home. So if they have an 80% of the purchase price is lent to you, you took out a loan for it. That's not the same thing as the bank owning 80% of your home. You own 100% of the home and you have a loan that has recourse on the home at the 80%. That's a little bit different. You can kind of see that difference because the bank can't basically make decisions about what you do with the home generally. They're not going to say, hey, I want to color the house green. And so we're going to paint it green. They don't get any say about that. They only get to say about anything if you default on the payments because at that point in time, that's when they got the recourse at that point. So you will normally be asked to agree to a mortgage clause when you take out a mortgage. In effect, a mortgage clause is a separate agreement between your mortgage lender, the mortgagee. Notice that those terms, the mortgagee and the mortgageor can get a little bit confusing for people if you're not used to those terms. So once again, the mortgage lender, the mortgagee and the insurance company that is insuring your property. A mortgagee clause ensures that if your property is damaged while you are paying off the mortgage, the insurance company will pay your mortgage lender for this loss, even though it's covered on your insurance policy. A lender would not lend a substantial amount of money secured by a property without the inclusion of a mortgagee clause in the borrower's property insurance policy. So they are an important part of the mortgage and property insurance contracts. Mortgagee clause definition. Most mortgagee providers, mortgagees will require you the borrower or mortgageor to take the homeowner's insurance in order to get a loan. Homeowner's insurance provides you with protection against damage to your property and its contents, but it's also provides protection for your lender. The mortgagee clause is a key part of these protections. So let's go through that one more time. The mortgagee clause definition. Most mortgage providers, that's the mortgagees, the lenders will require you the borrower or the mortgageor to take out a homeowner's insurance in order to get a loan. The homeowner's insurance provides you with protection against damage to your property and its contents, but it also provides protection for your lender. So clearly that's going to be a benefit to the lender as well because, again, the home is going to be the collateral on default of the loan. The mortgagee clause is a key part of these protections. So a mortgagee clause states that if a property is damaged during the mortgage period, the insurance company must pay the mortgagee for this. For example, if you obtain a mortgage to buy a home or property and that property is then destroyed in a fire, the mortgagee clause would ensure that the loss would be payable to your lender even though it's part of your insurance policy. This clause also protects the lender in the event that you cause damage to the property, which leads to insurance providers to cancel the policy. For example, if you commit arson, an act that would void your insurance policy, the clause protects the mortgagee ensuring that your lender will still be covered. So you got that classic kind of example where you did something that means that it's not going to be something that the insurance company will cover with regards to you, but then what about the lender? The lender is still going to be involved in that. They're not the one that committed basically the arson in that event. So you would think that they're going to want to be secured in that situation. So how a mortgagee clause works. Most lenders require borrowers to have homeowners insurance and that the insurance policy include mortgagee clause. The policy will state who has to lean within the policy in some cases. If it's not a requirement to get a mortgage clause, a borrower must contact a lender to add the clause to their current contract. Mortgagee clauses provide valuable protection for lenders because of the way that mortgages work. When you take out a mortgage, you are essentially offering your home as collateral for a loan, which you promise to pay back. So remember how it kind of works here. People often kind of confuse this whole thing. Kind of clump it together as if like the bank is your partner and you're going into buying the home as the bank being your partner. Or they're often say that the bank owns like 80% of the home, which I understand what they're saying there, but it's also not totally right. You don't want to internalize that as actual fact. That's kind of an overstatement when someone says, hey, the bank owns 80% of the home. They're kind of overstating the fact that the bank that they got this big loan on it, but really what's happening, of course, is you're purchasing the home. That's between you and the and the home and the seller. You're buying the home, which is an asset. So you have the home. The home is yours. You own 100% of the home, but you had to take out a loan to finance it. So now you got the asset on the books and then you've got the financing, which is the loan, which is a liability. The net of the two is kind of the net asset impact on like your financial statements, but a loan is not the same thing as a partnership kind of agreement in the home. Because again, the bank doesn't have any recourse on the home unless you default on your obligation to pay under the loan in general. So the bank doesn't can't come over and say, hey, I want you to paint the home green. I want you to rework the driveway or this or that, you know, they don't have a vote even though you own 80% of it in financing terms. That's what you use to pay the home. They only kind of step in when there's a default. So if you can't keep the promise, your lender, the mortgagee can foreclose on the property and sell it to recoup costs. But if the property is damaged, the mortgagee's investment is put in jeopardy. The mortgagee clause ensures that the mortgage will be paid out even if you are responsible for the damage to the property. So clearly, you know, the house is collateral in the event that there's a problem. And so, but what if the home is actually damaged? Well, then they're going to want the, obviously the lender wants to be covered in that event, even if you are not covered in it because you violated some kind of rule within the agreement. So in other words, a mortgagee clause is a form of indemnity protection for the lender because if there is any loss or damage to the collateral property, the lender is indemnified up to the interest it has in that property. Mortgage clauses are an important component of the mortgage of the mortgage market. That's because without the protection of the mortgage clause, financial institutions would be unlikely to loan the large amounts of money necessary to purchase homes, office buildings or factors. So remember this whole process of the banks, what the banks are doing are they're mitigating the risk and reward process. These are long-term contracts. They want to give out the loan because they want the interest. They're making money on the interest, but they got to mitigate the risks involved. So obviously the collateral is a mitigation of the risk. That's why you have the collateral. But if you're not going to get paid back, if some other event happens, like, you know, it's not qualified. You no longer have the home anymore and you're not going to get paid back. That would increase the level of risk substantially, which is what they're trying to mitigate here. If you can mitigate that risk, if you can lower the risk to the bank, that's usually going to be better. They're more likely to give out the loan. So what is a mortgage clause example? Mortgagee clauses protect your lender from damage to your property even if you caused it. So even if you're the one that did the arson, you wouldn't get any insurance yourself possibly under that circumstance. But the lender wants to be covered. So for example, if you commit arson, like you burned your house down and act that would void your insurance policy. So clearly if you burned your own house down, the insurance policy usually will have that as an exception to having to pay you for it. The clause protects the mortgage ensuring that your lender will still be covered. So the lender is going to say, I didn't burn the house down. I want to be covered under this because I can't sell the home anymore because he burnt it down. So is the mortgage the borrower? No, the mortgagee is the lender, specifically an entity that lends money to a borrower for the purpose of purchasing the real estate. So obviously the mortgagee is going to be the lender that's trying to be protected. They're protecting the collateral in the event that the borrower, the mortgagee, doesn't pay their money. So in a mortgage transaction, the lender serves as the mortgagee and the borrower is known as the mortgageor. Again, those terms are often confusing if you don't use them a lot. So can a person be a mortgagee? So yes, anyone who lends you money to buy a home and enters into a mortgage contract with you can be a mortgagee. So in other words, when you take out a loan, you're most likely thinking financial institution, bank perhaps, that you're taking the loan out from. But it's possible that you get a loan from a person. A person, if they're going to loan you the money to get a home, is going to want the same kind of safeguards. They're going to want the collateral and they would want this kind of agreement to be able to safeguard themselves, mitigating the risk just as a financial institution would. When you sign a mortgagee contract with an individual, it's called a private mortgage. So the bottom line, what's the bottom line? The mortgagee clause is a part of your homeowner's insurance policy that protects your lender, the mortgagee, from losses incurred due to damage to your property. Many mortgage providers will require there to be a mortgage clause in place in order to grant you a mortgage. A mortgagee clause states that if a property is damaged during the mortgage period, their insurance company must pay the mortgagee for this. For example, if you obtain a mortgage to buy a home or property and that property is then destroyed in a fire, the mortgagee clause would ensure that the loss would be payable to your lender even though it's part of the insurance policy.